FDI in Defence

Despite the intent, government policies still inhibit effective joint ventures

Cdr S. Shrikumar (retd)

With a view to speedily end dependence on import for its defence needs, government of India, in the year 2001, opened up defence manufacturing to the private sector. Previously, private sector participation in defence had been widely viewed as a transgression of national security. Initially, FDI in defence of up to 26 per cent was allowed under the automatic route. Later, in 2015-16 this cap was raised to 49 per cent.

In March 2018, government of India (GoI) released a draft Defence Production Policy (DProP 2018). It targeted the creation of an industry-friendly business ecosystem to promote domestic production of defence equipment by the public sector, the private sector and MSMEs.

The provisions of the DProP 2018 aimed to enable India graduate from being among the largest importer of arms in the world to being self-reliant in its defence needs. Some of the enabling provisions and incentives that were proposed included:

  • Rationalising the taxation system to support domestic defence manufacturing.
  • Streamlining the defence offsets policy to enable speedy execution of offset contracts.
  • Enhancing the FDI cap from 49 per cent to 74 per cent under the automatic route for certain niche technologies.
  • Setting up of an Aeronautical University in a 50:50 cost sharing partnership between Hindustan Aeronautics Ltd (HAL) and GoI to address the issue of skill shortage.
  • Setting up of a corpus of Rs 1,000 Crore (USD 140M) to fund start-ups to meet specific defence R&D objectives.
  • Easing and speeding up of the industrial licensing process.

In mid-December 2019, at the 2+2 dialogue held in Washington, the Industrial Security Annex (ISA) to the India-US General Security of Military Information Agreement (GSOMIA) was signed. The ISA provides the framework for exchange and protection of classified military information between the US and Indian defence industries. The ISA, it is expected, will open the door to greater cooperation between US defence firms and firms in the Indian private sector.

In mid-May 2020, the GoI announced the formal coming into force of one of the key proposals of DProP 2018—enhancement of the FDI cap from 49 per cent to 74 per cent under the automatic route for certain niche technologies (FDI up to 100 per cent may also be permitted with GoI approval).

The GoI’s efforts, over the last two decades, to enhance private sector participation in defence manufacturing through the measures enumerated above, are motivated by three principal reasons:

  • The less than satisfactory performance of the state-owned enterprises in fulfilling the requirements of the armed forces—despite the extended, virtually monopolistic run given to them.
  • In the relatively short time since 2001, when defence manufacturing was opened up, the private sector has proved itself capable of assimilating and managing the technologies.
  • Defence manufacturing requires large investments.

The private sector has demonstrated its ability to raise large sums of capital and to make substantial investments in essential assets, resources, acquisitions, joint ventures (JVs) and other capabilities required to undertake defence production.

However, despite the many policy initiatives, the expectations of attracting large scale FDI in defence have been belied. Very little FDI has been channelled by foreign defence companies for forming JVs with Indian defence firms.

The actual FDI inflow into the defence sector, currently, stands at just Rs 77.72 crores (USD 12.34 million) for the period from April 2000 to September 2021 (www.dipp.gov.in). The total FDI in defence, in the two decades since April 2000 amounts to less than 0.002 per cent of the total FDI inflow into India in the same period.


The Roadblocks

Clearly, the mere raising of FDI limits will not suffice to attract FDI into India’s defence sector. Concern around long-term financial viability is the principal roadblock stopping FDI inflow into the Indian defence industry. There are other concerns too.

FDI approval is contingent upon the investee company complying with stipulations on how it can structure its operations. The FDI policy, requires the investee company to be structured such that it is self-sufficient in the design, development, manufacture, and life-time support of the product that it proposes to manufacture in India. The investing/ investee firms, would like to be given a free hand to choose a structure for their operations that places them in the best position to attain their business goals.

Such provisions, although well-intentioned, introduce policy ambiguities, are difficult to implement, and only serve to scare away potential investments (the assessment of ‘indigenous content’, in defence equipment manufactured in India, continues to be a subject of long-standing contention).

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